Inside the Fed’s Alternate Reality

Leif Eriksson, a Viking, apparently set foot in Canada before Christopher Columbus hit the continent. Yet Columbus is routinely given all the credit for "discovering America."

And speaking of America, we allegedly fought our Civil War because of slavery.

Wrong.

The Civil War was fought to prevent the South’s secession. As such, Abraham Lincoln’s decision to go to war had almost everything to do with centralizing power into a Federal government and nothing to do with the immorality of slavery.

Myths like these get repeated often enough until they are no longer myths.

Repeat, repeat, repeat — and it’ll eventually be as good as true.

Sounds like the standard operating procedure for politicians.

And you can bet it’s the Federal Reserve’s game plan, too. (Yes, this is where I’m going with it. But I have a good finale … so keep reading.)

The efficacy of the Fed’s monetary policy depends entirely on their ability to make most people believe their policy is effective.

Yeah?

I spoke with Brad Hoppmann last week. One of the items we discussed was how long until we see another financial crisis of similar proportions to the Great Financial Crisis of 2008.

Before Brad could even offer me his time frame, I made a statement to suggest it’ll probably be longer than we both think.

To be sure, Brad has plenty of very good reasons why the status quo is unsustainable. And so do I.

My only question is: Does it even matter?

I went on to say something along the lines of …

"The Federal Reserve still seems to have everything under control."

Brad knew what I meant. But let me clarify for you just in case …

The Federal Reserve, as the ringleader of the global central banks, has done a sufficient job of convincing the general public that their monetary policy efforts have worked, are working and will work.

Yes. Good. On we go.

Do most people — do I — really believe the Fed has it all under control?

No, of course not.

But most people probably do believe the Fed doesn’t not have it all under control.

You see, the Fed has proven, time and again, they’re not exactly in tune with reality. Ben Bernanke’s Fed, for example, clearly misread the landscape in the months (if not years) leading up to the financial crisis.

So, in order to save face, the Fed creates an alternate reality … one that they can control.

And they do this with illusory correlations. This makes their potential to succeed a more available possibility than their potential to fail.

In other words, as long as the general public thinks they can control their alternative reality … and that their alternative reality actually has some bearing on real reality … then they believe Fed has it all under control.

Or, at the very least, they don’t believe that the Fed doesn’t have it all under control.

You see the problem, don’t you?

One domino falls and the whole convoluted thing crashes.

And that one domino is a crisis of confidence. Always has been, ever since ancient Greek and Roman "banks" started taking account for people’s gold so it didn’t have to be physically moved from city to city for transactions.

And it always will be. In fact …

A crisis of confidence triggered the financial crisis.

Think about it: The bloated, tightly-coupled, ethically-bankrupt, collateral-empty amalgamation of subprime loans, asset-backed securities, collateralized debt obligations and credit-default swaps would still be humming along today … if people didn’t lose confidence in the humming.

A crisis of confidence will trigger the next financial crisis, whatever it looks like.

Nothing else matters.

In predicable fashion, Janet Yellen, last week in a panel discussion, joined the three former Fed chairmen who are still alive.

I didn’t watch it. And I think that’s probably for the best.

But I did read The Wall Street Journal’s coverage of it where Yellen said one of the most-repeated words in the history of Fedspeak: transitory.

As in, inflationary pressures are transitory.

As in, weak inflation is due to transitory factors.

In essence, the word "transitory" has come to mean "pay no attention to the commodity prices behind the curtain." It doesn’t matter if commodity prices are rising or falling either — transitory still applies.

Because that’s all it really is — the Fed is saying commodity price pressures are everywhere and always temporary.

Just thinking about the tiresome logic and listless repetition of this transitory meme makes me want to throw my hands up in concession and say, "Fine, if you say so."

Ultimately, a crisis of confidence boils down to human nature. Economic data will tell a story. The financial system will offer cues. But the market will provide the best indication of when things become too much.

"Too much" in the context of the markets is the same thing as saying overbought or oversold. And since an oversold market is not suggestive of trouble to come, it is an overbought market that will warn us to a coming crisis of confidence.

It’s why I went as far as suggesting to Brad, "I think we could actually see a major blow-off top in the broader market before this pending crisis hits."

I know — it’s crazy to consider.

For some reference, consider that the S&P 500 has risen about 10% since Feb. 2, when I first alerted my readers to the potential for a "blow-off, bull-market rally."

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It’s good to see someone else who realizes that Lincoln had nothing much against slavery. After all, he grew up where slavery was the norm, and he said, himself, that he would be glad to see slavery continue, if it meant the preservation of the Union. He fought to preserve the Federal system, at the cost of the right of the states to largely govern themselves. He began the process of turning a Union of states into a single State. By 1860, slavery was largely an anachronism, and would very likely have begun to die off naturally within a few decades, as machinery replaced much of the human labor in agriculture – much as automation is replacing human labor in factories now. Slaveholders would have freed themselves of the responsibility for keeping their labor alive, just as manufacturing companies are now freeing themselves of the responsibility for their repetitive labor.